Your Guide to Uncovering the Best Seller Financing Deals

Seller financing is my favorite way to buy real estate. It is often faster, easier and more profitable than any other financing technique because no banks or third parties are involved.

In this article I’ll tell you how to find the best seller financing deals by targeting a particular type of property owner.

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Why Seller Financing is So Powerful

Although most of my real estate deals involve seller or creative financing, I don’t hate banks. I just like keeping the profits banks normally take for themselves. Haven’t you noticed that the biggest, most expensive buildings in towns are banks?

Here is why.

When a person with equity sells a house, that cash usually goes into a bank at a wonderful rate of .5% interest. Then that bank loans you (if you are lucky) that same money at 6%. This concept is called making “the spread” or a profit from other people’s money (OPM). Banks are masters at this, and the formula allows them to build those big, fancy buildings.

Seller financing, on the other hand, is all about keeping those profits and splitting them between you and the seller.

My First Seller Financing Deal

Before my first seller financing deal, I had only read about the concept, so after this article you will know about as much as I did. My real world education came from a wonderful, retired couple who owned a house near me and who decided to call me after I sent them a letter.

My letter to them stated that I would like to buy their house. They received this letter because they owned a house in my target market, but their mailing address was in a different town (called an absentee owner list).

This sweet couple’s house was vacant. It had been empty ever since the last tenant tore it up and moved out without paying. This had been their residence for years, and they then decided to rent it out to supplement their tiny retirement income. It broke their heart to see the horrible treatment of the home by the tenants, and they could not bring themselves to rent it out again.

This is the big clue to find your ideal seller financing candidate. They need to be a burned-out landlord or someone who is fed up with tenants, toilets and headaches.

This particular negotiation was a learning experience for me. Convincing them to finance the purchase was not a quick, easy sort of transaction. The fast, sleazy, manipulative, NLP-type junk that you’ll hear from some investors and educators would not have worked.

Why? Because a prerequisite to seller financing deals is a relationship. To have a relationship, you need to have mutual trust. And to have trust, you can’t be a slick slime-ball!

Do yourself a favor and just be yourself during negotiations. Drop the one-liners, be sincere (even if that means showing you are brand new and nervous) and ask questions.

Once I had built some trust, I earned the right to explain my case and to present options to the couple. One of my options was an all-cash offer, but the price was too low for them.

My second option was for the couple to get a higher price, receive a small down payment from me and then receive the balance of the price in monthly installments of principal and interest. After some discussion and thinking on their part, they accepted my offer.

This type of deal benefited me and benefited the seller. In the end I made a good profit by selling it to my tenant. The selling couple relieved themselves of a headache property, and they supplemented their retirement with a nice income stream and eventually a big lump-sum payment.

Why Is a Burned-Out Landlord More Likely to Finance to Me?

I have bought properties with seller financing from all types of people. One time I sat down to study the most common types of sellers who had financed their property to me.

The results confirmed what I already suspected — well over 50% fit into the category of a burned-out landlord.

I define a burned-out landlord as any rental property owner who has become fed up with the business of owning rental properties. If you study landlording, you know how difficult your life can be if you don’t maintain your property, if you don’t screen your tenants properly or if you don’t run your rental like a true business.

The truth is that many landlords do not study best practices. If they would read Brandon Turner’s awesome tenant screening guide or the BiggerPockets Forums, they would avoid half of their problems. But they don’t.

So mismanagement leads to property problems, and these problems make the sellers more motivated. Often these sellers think they just want to cash out like everyone else does.

But there are several reasons that these burned-out landlords might want to consider financing instead of cashing out right away.

3 Reasons Landlords Would Consider Seller Financing

1. Burned-Out Landlords Still Like Monthly Income

In the very beginning, the burned-out landlord started renting the property for a reason. They probably liked the idea of regular, monthly income. When the tenant paid on time and never complained, it was a great deal. But once the tenant problems started, the fun and games were over.

So if you earn the right to present your case to a seller, your task is to show them that regular, monthly income is a primary benefit of seller financing.

I like to share with the seller that I will take over all rental headaches. I will handle all communications with the tenant, all toilet and maintenance problems and all risk of vacancy. They will get a check from me on the first of every month no matter what, and they will never get requests from me unless it’s to ask them if they liked their annual Christmas cookies!

If they believe me, I have essentially taken away their biggest reason for selling and then given them back their original reason for renting in the first place. That’s a powerful combination!

2. Burned-Out Landlords Still Like Real Estate as Security

The sellers I like to talk with usually either own their property free-and-clear or have a large chunk of equity. This means that if they were to sell for cash, they have a serious dilemma. Where will they put that big chunk of money?!

First, if they value security, they may put the money in a bank account. This is certainly safe, but they have traded away any hope of a decent yield for that safety.

Second, they may consider the stock market. If they are anywhere near retirement, this option will give them the cold chills. They have probably been around for a while, and they know the manic, up-and-down nature of stock market pricing.

Third, they could opt for bonds, insurance annuities or other more complex financial instruments devised by the experts on Wall Street. While these may make sense for some people, I am betting that an investor who got into real estate liked income properties because they were local, simple and understandable.

Based upon this reasoning, I sell security and simplicity as major benefits to seller financing. I remind them of my favorite investment questions, “What is the worst thing that can happen? Am I ok with that?”

I tell them that in that worst case scenario, I get run over by a bus and my heirs stop making payments. They would then keep everything I’ve paid them and then get the property back. So they are back where they started. Not great, but it better than uncertainty.

I have found that uncertainty is one of the most terrifying risks when making decisions. By reminding them that a property they already know very well is their security, I have reduced or eliminated much of the financial uncertainty and fear in their decision-making process.

3. Burned-Out Landlords Sometimes Have a BIG Tax Problem

This reason is especially important in high-priced markets where appreciation has grown property values for years (big cities, California, Florida, etc). Ironically, in the modestly appreciating market I live in (Clemson, SC), this reason has been the least important to convince sellers to finance to me.

Imagine an owner of a duplex who bought a property in a good location 25 years ago for $100,000. If her market price appreciated at 5% per year, the current price would be $338,636. That is a capital gain of over $238,000 recognized in one tax year!

The problem with this scenario is that the owner will pay taxes on this gain, and if the owner already makes a very high income, the tax burden could top out at 23.8% of the gain based upon 2014 tax rates. That would mean 23.8% of $238,000, or $56,644, would be owed to the IRS and would never earn interest again!

The owner could avoid this with a 1031 tax-free exchange, but my ideal seller isn’t trying to get into more rental properties. She is primarily trying to avoid more hassles.

An installment sale (which is recognized by the IRS) is a way to defer a large portion of the tax until later without finding a replacement property. This can help the seller plan her tax burden more wisely.

In my example above, the seller could spread out the $238,000 gain over a longer number of years, which might result in a lower tax liability depending upon the particular situation. Very importantly, the seller will also earn interest on what would have been taxed. At 6% of a $56,644 tax liability, this could be a positive benefit of $3,399 in just the first year.

Because this situation can become very complicated, the seller should of course be advised to consult with their own CPA or tax attorney about the impact on their particular situation. It’s your job to just bring the possibility to their attention.

Will You Do Anything With This Information?

Remember my first seller financing deal? The big step was that I learned a good idea, and then I immediately took action. Trust me, I was not perfect in that negotiation. Yet I still got a good deal because I was willing to ask.

So do you have a deal you’re working on that you could make a second, higher-priced offer with seller financing? Do you know of any burned-out landlords in your town? Are you willing to mail letters to possible candidates or talk to property managers of those owners?

If you have at least a little bit of capital, and if you are willing to take action and ask questions, you can also land your first seller financing deal. Good luck!

Let me know if you have any questions or comments below. I would love to hear from you.

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About Author

Chad Carson invests in Clemson, South Carolina. He also writes at coachcarson.com about using real estate investing to retire early & do what matters. For practical advice each week — join his free newsletter at coachcarson.com/newsletter.

Not sure what you mean by “Bait” Tim. The one and only attitude I have towards my reader with this part of the article is a positive challenge … you’ve heard the information, now go and do something with it. It’s meant to encourage.

Chad,
I see you did not take into account recaptured depreciation in your example of the Burned-Out Landlord. If they bought it 25 years ago for $100k, they would have about $90K to recapture at earned income rates in the year the installment sale begins (Please correct me if I am wrong here). Why would the Burned-Out Landlord opt to pay $18,500 in taxes (Assuming she did not make anything else that year)? Do you offer her at least that much down? Do you just let them deal with it later? Do you even worry about it?

I ask specifically about the recaptured depreciation because I am looking to do a deal with my Dad on some rental property he owns. He is quickly becoming a Burned-Out Landlord and would like to move on. I have several rentals and his would fit nicely into my portfolio. He has depreciated the properties for about 15 years, does not particularly want to do a 1031 exchange, and has refinanced above his basis. I just don’t know how I can acquire the buildings without costing my Dad a small fortune in taxes. Any ideas?

What comes to mind specifically in your dad’s case is maybe doing a long-term master lease with an option to buy. Avoid the sale, at least for a while, to build up some cash for him to pay the taxes on the depreciation recapture when and if you do buy it. You might be able to accomplish what he wants … avoid headaches of landlording, and what you want … control properties using the seller’s equity.

Yes, there would be tax on depreciation recapture. I believe the rate is 25%. I didn’t mention depreciation recapture in part not to confuse the introduction to the topic and because it’s not a benefit for the seller. It’s an objection to overcome. And yes, I would consider making a big enough down payment to cover all or part of it and/or letting him do a small refinance to pull out some cash. Especially with a private lender doing that refinance, you could then do a wrap around mortgage for your seller financing terms.

There is always a lot to consider with disposition of rental properties. It’s good to have a rough understanding of income tax issues, and then have a good CPA to help out.

Chad, you mentioned paying more, paying more than what alternative financing would be is a mistake! Financing does not make a property more valuable. Look at the amortization and make certain that at any point where a sale or refinancing option is necessary that you’re not upside down. You’re also financing future equity gained by appreciation which goes to the buyer.

You should be able to show the benefits of seller financing to a seller without giving away the farm, the higher rate as to their alternatives is good enough, their security is a property they know well, the tax advantages of paying with future dollars is another advantage, so throwing in a high price just isn’t warranted.

I’ve picked up landlord portfolios using their equity to fund the deal, it’s a great way to find motivated sellers, retirement is the ultimate goal and getting a retirement annuity is pretty nice.

I don’t think the definitive guide to seller financing has been written yet, but someone may have used the title. 🙂

Hey Bill. Thanks for the reply. I have always enjoyed reading your posts in the forum.

I disagree that that paying more to get attractive financing is always a mistake. Sure, all things equal I want the lowest price possible regardless of my financing. But risk comes in a lot more costumes than just a higher principal balance, and sometimes it’s worth paying more to reduce long-term risk and increase long-term profitability.

The other terms of the financing also make a big difference in the riskiness of the deal. For example just to name a few: payment, balloon date, personal guarantee or not, interest rate, substitution of security, first right of refusal, etc. I can control these terms much easier with seller financing than through a bank, therefore I can control and reduce my risk.

I will concede that during the initial few years of a loan, should I have to refinance or sell I am in a less optimal situation than with traditional financing at a lower price. But the whole point of paying more is to get terms that DON’T make me sell so soon. If I hold my seller financing property for more than say, 5 years, a 3% interest rate seller financing will beat socks off the 6% traditional loan forever more. Very often my amortization tables (yes, I know how to use them:), cross about year 5 or 6, right when I would have had to refinance, pay more fees, or get my loan called using traditional loans.

I would pay $10,000 more, for example, all day long if I knew that after 5 years I’ll be on equal grounds but in the mean time all of my other terms are more attractive. With long-term holds the important thing is profitability and risk reduction over the life of the loan, not just in the first few years.

Plus, if I get a substitution of security with seller financing, even selling the property at a small loss might make sense if I pay off 8% money with my 3% money on a substitute property. I’ll make up that loss quickly, again, over the long run.

Thanks Chad,
Are you, as the buyer and the one encouraging the seller to enter into this agreement with you, responsible for creating an ammortization schedule? Do you send this with your monthly payments? In a normal bank situation, they send you an invoice with this information, but with seller financing, who does it?

Quick question: On average, how much of a down payment do you feel should be present to the seller to make the deal more attractive to the seller(s)? 20%? 40%? What number has worked for your seller-financing deals, or does each deal dictate what your approach will be?

Many times I am able to negotiate the best seller financing on properties that need a lot of repairs or delayed maintenance. Therefore, I will likely sink 5-15% of the purchase price into repairs up front. So I use this fact, along with a detailed repair list, to offer a lower down payment in the 0-10% range.

I also offer to put the requirement in our purchase contract and in our note that I have to perform these repairs within a certain period of time. This may make the seller feel more comfortable (understandably) that I have true skin in the game.

With all of that said, this entire game is about decreasing risk while also maximizing my return on cash. So if I can do either of those (reduce risk, increase return) by offering more down, I have no problem doing it. It really is a deal by deal analysis.

For example, I have paid 50% down in one extreme case on an expensive house, but I got very good interest rate and payment terms from the seller. The seller agreed to substitute the collateral for that equity to a few other properties I owned as rentals. So I fixed and sold the house, recouped the big down payment, and used the rest of the cash from the sale to pay off my higher interest loans on the properties that I was keeping as rentals. The seller now has a first mortgage against these rental properties and I continue paying the seller for the duration of the term in the original note.

Just one particular case when a bigger down payment made sense. Others may not. Good luck!

I love this article. Just bought my first SFR about 6 months ago with conventional financing, and I have been looking into seller financing as an option for the future. I want to acquire more properties, but was concerned about conventional financing becoming more and more difficult, with the debt-income ratio requirements and 20%-25% down payments. You clearly spelled out the benefits to the seller; and I like that it can be a mutually beneficial arrangement. Thanks for sharing. I also liked the challenge at the end. 🙂

Thanks Laurie! Seller financing isn’t as simple as walking into a bank, but I love that it has more to do with your efforts and negotiation instead of just the numbers on a bank application. Good luck with your own efforts, and glad you took the challenge the right way:)

I’ve been wondering about some things related to the seller financing concept, forgive me as I am still learning but what assurances are place to make people feel comfortable selling their house to a private investor? For example, how can they trust the investor will make payments on time or at all to them and what would happen if they don’t? What kind of contracts are in place with these sort of deals?

At what point would the investor actually own the home? Is it as soon as they provide the downpayment to the seller and starts paying or only after all the payments are completed?

Also, I read something somewhere on BP that said seller financing could be risky because if the seller’s bank catches on about the deal they could require the original home owner to pay back the loan in full immediately.
This is really confusing, can you clarify how the the payment system works from investor paying to seller and seller still making payments on their original loan??

You probably won’t have any luck with anyone above replying to your question here, seeing as you’re about two years too late. Something about BiggerPockets, whether users don’t remain active for extending amounts of time, or whatever it is, you usually don’t see replies this much later. Hopefully someone will come prove me wrong; though, after a month, I doubt they do. Maybe my comment will give them the notification they need to check back and include their own answers to your questions.

How can the seller trust the investor will make payments? What happens if they don’t?

No lender is a mind-reader. Not even the banks, despite them wanting you to think they are. No one can know for an absolute fact that their buyer, tenant, etc is going to pay their monthly dues. Instead, we rely on other forms of “trust” and leverage. A lender will review your credit score, debt-to-income ratio, and employment history among other factors to gather a certain “trust” in your ability and willingness to repay accordingly. An owner-finance lender should be no different. Further, much more often than not, a down-payment is required. This is a bit of a cash-cushion if the buyer ends up defaulting on payments. It’s the same general concept that applies to a security deposit on a rental lease. You don’t pay, they’re partially covered – at least long enough to hopefully push through either an eviction or foreclosure (other options for recapture subsequent to default can apply, it varies by state), depending on the financing structure used.

When does the investor actually own the home? After down-payment, or after total is paid off?

Again, this will depend on which owner-financing avenue you travel. For a Seller Carryback, you’ll own the property, legal title and all, at the time of sale/recording. For a Land Contract, you gain only “equitable title” at the time of sale/recording. You don’t outright own the property until after you’ve made your final payment and have satisfied the entirety of the lent amount.

If the seller’s bank catches on will this trigger the due-on-sale clause?

Well, in a Seller Carryback scenario, you’ve inevitably already cleared the title. Either they owned it free-and-clear from the start, or your down-payment extinguished the remaining amount. There won’t be a sale otherwise. As for a Land Contract, yes, you can potentially set one of these up without the bank noticing and hope for the best. But you can bet your last dime, if the bank finds out the property owner allowed a transfer of interest in the property without informing them, they’re going to require the remaining amount be paid immediately. I guess there’s always the chance that they could say “eh, payments are still being made, it’s no biggy” but that’s not the way I play the game – and I wouldn’t advice you to, either.

How does the payment system work? Investor < Seller < Bank?

This would apply more to either a Lease Option or a Wraparound Mortgage, where there could and very well may be an existing loan between the owner and their lender. Here, you would make your payments to the seller, almost 100% of the time at a markup of what the seller pays their lender, and the seller would then pass this amount along to the lender, pocketing whatever difference there was as profit. You just have to hope that they do their part. Honestly, you could always insert some language into the contract that states you are the one who makes the mortgage payments to the lender (bank likely isn't even going to bat an eye at who the payment is coming from) and then give the difference directly to the seller.

Hope this helps. Feel free to send me a colleague request and we can dig in deeper. Thanks!